What Is an Individual 401k Plan?

An individual401k plan is a qualified deferred compensation plan offered by a participating employer that allows an employee to contribute a portion of her salary or wages on a pretax basis into an individual retirement account. An employee receives distributions from the accumulated funds in her account after she reaches age 59 1/2.

Contributions to a 401k plan aren't included in income tax withholding or reflected on an individual's Form 1040. The reason for this is that they aren't considered taxable income until the funds of the plan are distributed. They are subject to Social Security, Medicare, and federal unemployment taxes. The Internal Revenue Code imposes restrictions on the amount that employees can contribute, and the terms of the 401k plan may also place limits on this.

Distributions after the age of 59 1/2 can be in the form of periodic payments or an optional lump-sum distribution. Generally, periodic payments from a 401k plan are subject to income taxes because they weren’t taxed when they were contributed.

Lump-sum distributions occur when the participant’s entire balance in her employer's qualified 401k plan of one kind is distributed in one payment within one tax year.

With few exceptions, an early distribution before the age of 59 1/2 is subject to an early distribution penalty of 10 percent of the amount distributed.

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